Prasad Production Ltd. (Taxpayer) was awarded a contract by the Government of the State of Andhra Pradesh to establish IMAX Theatre at Hyderabad. The Taxpayer entered into an agreement with IMAX Ltd., Canada for purchase of the system (which included supply of equipment, installation, testing and initial training) as well as transfer of technology. As per the agreement, the total consideration for purchase of the system was US$ 1,365,000 and US$ 950,000 was towards technology transfer fee.
During the year under consideration, the Taxpayer remitted US$ 902,500 to IMAX Ltd. on account of system cost without withholding tax thereon.
The Assessing Officer (AO) was of the view that the amount remitted by the Taxpayer was for provision of technical services by IMAX and was chargeable to tax in the hands of IMAX. The AO relied on the judgement of Supreme Court in the case of Transmission Corporation of AP Ltd. (239 ITR 587) to conclude that since the Taxpayer has not obtained any order for lower or Nil tax withholding, the gross sum remitted by the Taxpayer was liable to tax and accordingly raised the tax demand against the Taxpayer. The Commissioner (Appeals) cancelled the order of the AO holding that the amount of remittance represents a part of sales consideration of the equipment and hence not chargeable to tax at all. Aggrieved by the said order of the Commissioner (Appeals), the Revenue filed an appeal before the Income Tax Appellate Tribunal (“ITAT”).
Issues before ITAT
- Is it obligatory for the Taxpayer to withhold tax on the entire payment to a non-resident where no application for lower or Nil rate of tax withholding is made to the AO?
- Whether the Taxpayer has the discretion to determine charge ability to tax in respect of the remittance to the non-resident?
Contentions of the appellant [Revenue]
- Relying on the judgement in the case of Transmission Corporation (supra) and the decision of Karnataka High
Court in the case of Samsung Electronics (320 ITR 209), Revenue contended that the Taxpayer has no discretion to decide whether to withhold or not to withhold tax. If such discretion is given, the Taxpayer would sit in the chair of the AO and section 195 will become inoperative.
- Where according to the Taxpayer the entire sum was not chargeable to tax, the Taxpayer has to approach the AO for determination of rate of withholding. The Taxpayer cannot decide the taxability of the payment on his own, it has to be decided by the AO or a Chartered Accountant (“CA”) issuing the certificate on tax withholding.
- Tax withholding is only a tentative determination of tax and subject to assessment in the hands of the payee.
Contentions of the respondent [Taxpayer]
- Installation assistance and initial training were auxiliary to the sale of original equipment and were inextricably and essentially linked to the sale of equipment. Fees for installation assistance and initial training were not in the nature of fees for technical services and the amount of remittance represented a part of sale consideration of equipment, hence not chargeable to tax.
- In the case of Transmission Corporation (supra), it was held that tax is to be withheld only on that portion of the remittance which forms part of taxable income. The Karnataka High Court in the case of Samsung (supra) has extended the applicability of the decision in the case of Transmission Corporation (supra) to cases where the entire income may not be chargeable to tax. In the case of Samsung (supra), the Supreme Court decision in the case of Eli Lily (312 ITR 225) was not considered wherein it was held that where a particular income is not chargeable to tax, then the withholding tax provisions cannot come in.
- Tax is to be withheld only if income is chargeable to tax under the ITA. Income is chargeable to tax if it is a part of the total income of the payee and not otherwise. Where income is not chargeable to tax, there would be no withholding tax liability under the ITA.
- The revenue has through various circulars given a choice to the Taxpayer to either apply to AO under section 195(2) or to obtain a certificate from a CA in lieu thereof. This aspect has not been considered by Karnataka High Court in Samsung decision.
- Section 195(2) is not mandatory. Application for lower or „Nil? tax withholding under section 195(2) is supplementary to section 195(1) and if the Taxpayer has a bona fide belief that the amount is not chargeable to tax, then the Taxpayer need not undergo the procedure under section 195(2).
- It was contended that the Samsung decision is contrary to various Supreme Court and High Court decisions including earlier decisions of the Karnataka High Court as well as the circulars issued by the Revenue and thus the same is not binding.
Observations and Ruling of the ITAT
- In the case of Transmission Corporation (supra), the argument of the Taxpayer was that section 195 is applicable only if the whole of the payment constitutes income chargeable to tax which was rejected by the Supreme Court.
- As per the decision in the case of Transmission Corporation (supra), the person making payment to the nonresident would be liable to deduct tax at source if the payment so made is chargeable to tax under the ITA. Impliedly, if the payment is not so chargeable, the payer would not be liable to withhold tax. This is again clarified by the Supreme Court in the case of Eli Lily (supra).
- Where the Taxpayer has a bona fide belief that no part of the payment bears income character, section 195(1) would be inapplicable and hence there is no question in going into the procedure prescribed under section 195(2).
- The ITAT rejected the argument of the Revenue that the Taxpayer cannot decide the tax ability of payment on its own and it has to be decided by the AO or the CA from whom the certificate of tax withholding is obtained. The ITAT observed that where the Taxpayer is expected to know what income is taxable in his own case, the Taxpayer can certainly consider the charge ability in respect of payment made to the payee. Here the Taxpayer is only considering the charge ability of a particular income for withholding tax and not determining the tax liability of the total income of the payee. Thus, it is the Taxpayer who is the first person to decide whether the payment he is making bears any income character or not.
- The payer is an assessee and liable to the assessed for withholding tax. The payer has the right to defend the proceedings against him in respect of withholding tax, despite the entire exercise being tentative in nature. The ultimate result would depend on what is determined in the assessment of the recipient. The result in the case of the recipient will determine whether the payer can be treated as assessee in default or not.
- If the payer is under bona fide belief that no part of the payment is chargeable to tax, he is neither required to approach the AO under section 195(2) nor is he required to furnish the CA certificate. CA certificate is to be obtained by the payer for complying with the manual of Reserve Bank of India for the purpose of making remittance as mandated by the circulars of the Revenue.
- If the bona fides of the payer are doubtful, the payer will have to face all the consequences under the ITA. Ultimate liability of the payer as well as consequence of dis allowance of expenses on account of non-deduction of tax at source would depend on the assessment in the case of the payee.
- In the present case, the agreement between the Taxpayer and IMAX is very clear to point out that IMAX is to install the equipment, test it and also provide training for up to four projectionists. The AO has mistaken these services to be as payment of technology transfer whereas they are auxiliary to the sale of the equipment. The Revenue has not been able to show cause that these services are independent of the equipment. Thus, US$ 902,500 being part of equipment price is not chargeable to tax in India and Taxpayer was justified in not withholding tax thereon.
The obligation to withhold tax does not arise if the payment is not chargeable to tax. The payer can decide whether the payment to be made is chargeable to tax or not. Where the payer has a bona fide belief that no part of the payment bears income character, payer would not have any liability to withhold tax thereon. As the tax is not deductible in such a case, payer is not obligated to seek a withholding tax determination from the AO as prescribed under the ITA.
Source: ITO Vs M/s Prasad Production (ITA T Chennai Special Bench) ITA No. 663/Mds/2003, Decision dated 9 April 2010